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Woodside shareholders lose to Shell

The use of shareholders’ funds to buy-back shares owned by Shell comes at a big cost to the company’s other investors.

Summary:Woodside plans to use $US2,680 million of shareholders’ funds to buy-back 78.3 million shares from Shell. Most of the payment is a fully franked dividend, which carries $US882 million in franking credits. Woodside shareholders (other than Shell) get nothing.

Key take-out:Woodside calculates the benefit from the transaction is a US12 cent increase in annual dividends. The full amount paid to Shell would pay a fully franked special dividend of $US2.50 a share to all shareholders.

Key beneficiaries:General investors. Category:Shares.

Woodside announced on Monday that it plans to buy-back 78.3 million of its shares held by Shell. This is 9.5% of Woodside’s issued capital. Woodside will pay Shell $US34.24 ($A36.49) per share. The buy-back price has been split into a fully-franked dividend of $US26.29 and a capital component of $US7.95.

The cash payment to Shell will be $US2,680 million ($A2,857 million), consisting of dividends of $US2,058 million and $US622 million capital component. The cash payment of $US34.24 ($A36.49), is a 14% discount to the market price ($A42.43) at the time of announcement.

In separate transactions this week, Shell sold another 78.3 million shares (9.5% of Woodside) to institutional investors for $A41.35 per share. This is a transaction which does not involve Woodside.

Franking credits of $US11.27 per share go to Shell

The real cost of the transaction is $US45.51 ($A48.50) per share which is a 14.3% premium to the market price. The difference is the franking credits of $US11.27 ($A12.01) per share which are being given to Shell.

Why not a big special dividend to all shareholders?

Woodside calculates that the buy-back will result in future dividends being higher by US12 cents per year, based on 2013 results.

A fully-franked special dividend of $US2.50 ($A2.66) per share could be paid to all shareholders if Shell’s $US2,058 million dividend component was paid to all shareholders. (Woodside has 824 million shares on issue).

It takes over 20 years for the US12 cent higher dividend resulting from the share buy-back to compensate for not getting a $US2.50 special dividend now. The $US2.50 special dividend would be a certainty. The extra US12 cents per year for 20 years is uncertain and involves 20 years of risks.

Franking credits of $US1.07 ($A1.14) per share would attach to the special dividend, so shareholders would receive $US3.57 ($A3.80) before tax. All shareholders would benefit from the $US882 franking credits which this proposal gives to Shell.

A $US2.50 special dividend would cost Woodside $US622 million less than the Shell buy-back.

The special dividend could be $US3.25 ($A3.47) per share if the full amount to be paid to Shell ($US2,680 million) was paid to all shareholders. This is the equivalent of 27 years of improved dividends under the buy-back scheme.

Franking credits are valuable to all shareholders, including Shell

Franking credits are obviously valuable to Australian shareholders. They can use them to offset personal tax, and get a refund if franking credits exceed their tax obligations.

My tax accountant friends tell me that foreign shareholders, like Shell, also benefit from Australia’s franking credit system. Because the dividend will be franked Shell does not pay the 15% Australian withholding tax. As the dividend has been franked Shell does not pay the 25% Dutch company tax on the dividend. As a non-Australian company Shell does not pay Australian tax on capital gain from its Woodside shares. Dutch capital gains tax is 25%. As the very high dividend in the buy-back reduces the capital component to only $US7.95 ($A8.47), the Dutch capital gains tax is significantly reduced. My tax friends tell me that Woodside’s Australian franking credits are effectively reducing Shell’s Dutch capital gains tax.

Shell’s announcement allows me to work out the benefits of the fully franked dividends. The after-tax value to Shell of the Woodside buy-back plus the sale of shares to institutions is around $US5 billion. As total proceeds are about $US5,720 million, the total tax must be $US720 million. Shell says no additional tax is payable on the dividend, because of the Australian franking credits, so the $US720 million is Dutch tax on the capital gains.

That means that Shell’s average cost of the shares was about $US4.98. Without the dividend and attached franking credits, the Dutch tax payable on capital gains would be an additional $US514 million (25% of $US2,058 million). The franking credits given to Shell by this deal will save Shell $US514 million in Dutch tax, at a cost to Woodside shareholders of $US882 million in franking credits.

$A36.49 is worth more to Shell than $A41.35. Why?

Based on the tax effects advised by my tax friends the share buy-back from Woodside at $A36.49 is worth $A35.70 after all taxes, as only $US0.74 tax will be paid in the Netherlands and no tax in Australia.

The same friends tell me that the $A41.35 sale to institutions will incur about $A9.09 in Dutch tax, so be worth about $A32.26 after-tax.

Shell gets an unfair share of franking credits

Prior to this proposal Woodside’s franking credits are $US2,760 million ($A2,942 million). The buy-back gives 32% of the franking credits ($US882 million) for 9.5% of Woodside’s shares. The remaining franking credits will be $US1,878 million. How is this fair, or reasonable?

Shell has had no difficulty selling 19.5% of Woodside in recent times. Shell sold 10% of Woodside in November 2010, and a further 9.5% this week. Why is Woodside using shareholders’ money to help one shareholder (Shell)?

Note on exchange rates

The amounts are slightly complicated because Woodside does all its accounting and dividend payments in $US, but its shares trade on the Australian Securities Exchange in $A. All amounts are translated at the exchange rate quoted by Woodside ($US1.00 = $A1.0659). Even though the exchange rate changes every day, the outcome is about the same at all exchange rates unless a large change occurs in the next two months.

This is an edited version of an article which first appeared in The Dividend Man, John King’s blog at thedividendman.blogspot.com.au. John King is a director of AJK Consulting.

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